Whipsawed Beyond All Recognition

May 5, 2015

The dollar is one of many financial market prices caught up in a period of intense oscillation. Over the past five trading days, the DOW fell 1.6%, recovered 1.9%, and declined over 1.2%. After declining from 0.39% on March 6 to 0.07% on April 20, the 10-year German bund yield rebounded to 0.51% today. The comparable British gilt yield swung from 1.95% in early March to 1.50% eleven days ago and back to 1.97% at present. From $1.1036 on April 6, the euro fell to $1.0520 on April 13. The common European currency was as week as $1.0715 on the final day of the month but touched $1.1224 today. Since the 10th of April, sterling has swung between $1.4587 and $1.5492. Gold climbed from $1,150.70 at the close on March 11 to $1,218.60 on April 6 and $1,174.50 on May Day.

Markets this volatile present serious challenges. Analysis of economic fundamentals doesn’t capture these twists and turns, and technical analysis can leave one chasing the proverbial tail. Oftentimes, severe oscillation is an harbinger of major change in forces of nature and market behavior. That has clearer implications for equities and bonds, where it’s been a very long time since the last bear market. Implications for the dollar are much less obvious. During the 42 years of floating exchange rates, more multi-year downtrends than multi-year uptrends in the dollar have occurred. A bull market in the dollar is only now approaching its first anniversary. To be sure, the slope of the dollar’s rise in this bull run was extremely steep even by historical standards. In earlier multi-year dollar appreciations, it was common to see downward corrections that were sharp but lasting no more than a couple of months. Such corrections in the early 1980s happened in August-November 1981, November 1982-January 1983, and January-March 1984. A counter-trend movement enduring more than four months usually signals a dollar trend reversal, not a correction within a trend. Amid the saw-toothed pattern of the dollar and other financial market trends, this test of time may be the most reliable way of discerning if the dollar’s year-old strengthening trend is over.

The possible causes of a dollar downturn are not hard to identify. First, dollar appreciation has closed the performance gap between U.S. manufacturing and those of its main currency competitors. Second, the dollar has moved extensively already and is below its lifetime average level against the euro. Third, the U.S. political model seems broken and incapable of marshalling widespread support for any cause that promotes the general welfare. And fourth, the dollar remains king of the currency hill, making it an ever-present object of selling pressure to diversify currency portfolios.

The thing is, however, that Europe, Japan, and China face more daunting long-term problems than the United States. While the U.S.-centric financial meltdown of 2007-8 inflicted the more pronounced economic damage in countries other than the United States, the corollary isn’t going to hold if Greece defaults or drops out of the euro. Europe will pay the highest price. Since European 1999 abandoned a monetary system that revolved around the D-mark and many satellite monies for a common currency and single one-size-fits-all central bank policy, the dollar has in general performed better from the standpoint of maintaining value against a broad cross-section of other currencies, not just the euro. The coming few years should not be different in that regard. As for Japan and the yen, the most startling global economic change to occur during my long career as a market watcher is Japan’s transformed image from a powerhouse seemingly challenging America’s hegemony in the 1980s to a backwater that few take seriously. Because of what happened to Japan and the similarities of China now to the image of Japan a generation ago, it’s difficult imagining a great-enough drop-off in U.S. world leadership during the rest of this decade that would eclipse the dollar’s fundamental economic advantages.

Currency markets are in for choppy trading, but a dollar downtrend to 1.35 per euro or 100 yen would be surprising.

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on Tuesday, May 5th, 2015 at 2:28 pm and is filed under Foreign Exchange Insights and Next Week.
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